A collection of often sceptical, always candid observations and insights on the US economy and large-cap equity markets. Readers have observed my style and perspective to be that "the emperor has no clothes," and that is reasonably accurate.
Postings reflect my philosophies and perspectives on economics, business and politics.

Saturday, March 15, 2008

Today's blog visits saw quite a few readers seeking information for searches generally described by a phrase like'gasparino dennis kneale cnbc'Being on vacation and away from television during most of the market hours this week, I was clueless as to the reason for the search. Well, I should say clueless as to the particular reason.If Charlie Gasparino was involved, I could guess it was some sort of ugly, on-air fracas.Following one of the search results which also appeared along with one of my older posts, I found this YouTube video of Thursday's CNBC incident involving Dennis Kneale and Gasparino.

I have to say, I was surprised at how baseless and inappropriate Gasparino became during the exchange. The source which featured this clip noted that both Gasparino and Kneale were former Wall Street Journal staffers, which may account for the vehemence of the words they parried. It would not be hard to imagine the slightly-geeky Kneale and steroidish, hulking Gasparino not getting along well at the business paper.Sad to say, this on-air exchange reinforces my perception of Gasparino as not much more than a business gossip reporter. There's very little 'news' in the stories that he 'breaks' which really affects me, or my view of markets or business. His stories tend to accentuate personalities, feuds, and other non-substance-oriented topics.In contrast, I find Kneale to be insightful, intelligent and possessing much common sense.It's a pity that CNBC so prominently showcases an on-air reporter like Gasparino. In my opinion, he cheapens the network's programs by comments and behavior like that in the clip from Thursday. Why he thinks an unsubstantiated on-air, live accusation of Kneale as a fellow customer of Eliot Spitzer's call girl service of choice matters to viewers is beyond me.

Friday, March 14, 2008

Last weekend in the Wall Street Journal, former Dallas Fed President Bob McTeer wrote an insightful editorial entitled "Valuing The Dollar."

In his half-page piece, McTeer gave a learned, yet comprehensible tutorial on various factors affecting exchange rates. He differentiated capital flows from trade flows, explaining why sometimes the former offset effects one would expect from the latter.

Near the end of his editorial, McTeer wrote,

"The accumulation of massive dollar reserves in China led to worry that they would diversify those holdings at some point, a diversification that would involve moving the dollar into other currencies, especially the euro -- with such a sell-off depressing the dollar and leading to higher U.S. interest rates. Instead, the diversification so far has been from Treasury securities into private-sector dollar assets. To continue the current account deficit is to continue the fire sale of U.S. assets to foreigners.

They want to get into U.S. assets when the dollar is cheap and get out when the dollar is dear. The more the dollar depreciates, the sooner it will be expected to reverse, and the sooner foreign investors will resume their participation in the most dynamic, creative economy in the world."

The term 'fire sale' caught my eye. McTeer, like so many other learned, experienced businessmen or economists, wail about the sale of US economic assets to foreigners at distressed prices, due to the dollar's current value, relative to other currencies a year or so ago.I would like to argue the proposition that the assets being bought 'on sale' are, for the most part, assets that are no longer as valuable as they once were, and probably not the most dynamic, attractive part of our economy.For example, the 'fire sale' of US banking assets- Citigroup, Merrill Lynch, and Bear Stearns- is often used to prove the point that we are selling ourselves to foreign countries, companies or individuals.However, Goldman Sachs, Lehman, Wachovia, and many private equity groups and hedge funds have not sold interest in themselves to foreigners.Furthermore, how hard would it be for the healthier private firms to compete with the publicly-held, weakened banks and brokerages? This is a business which, we are reminded, has its most important assets walking out of the doors every night.What is so special about an ailing Citigroup or Merrill Lynch that can't be duplicated, or improved upon, by fresh capital behind better managers in new companies doing the same things.By contrast, nobody seems to be buying our economy's more successful and innovative firms, such as Google, H-P, FreeportMcMoran, bio-pharmas or manufacturers.Could it be that Schumpeterian dynamics is at work here? The weak firms are being bought by foreign acquirers, while the stronger firms remain above the fray.Then there is the issue of dynamism. To wring one's hands over our economy being 'bought' by foreigners is to ignore our pace of innovation and value creation.Firms like Google weren't anywhere near as strong and dominant even five years ago as they are now. Five years from now, new companies we've yet to completely understand will be joining them as dominating forces in their business sectors.It seems to me that, for example, the financial services firms which are the target of overseas investment are engaged in mostly commodity businesses. And poorly managed at that. What's the fuss about?Are we worried that foreigners will do a large amount of US unsecured consumer lending? Or corporate lending? These businesses are easily started by competitors, if that is a problem.Are we worried about foreigners' access to the US financial system? They already have it. And they already must submit to US regulatory scrutiny. It's unlikely that we will suffer because Citigroup sells more diluted equity to some Arab interests.

Are we so sure that the companies being 'lost' to foreigners are where we have sustainable competitive advantages which will result in long term, consistently superior total returns?

Personally, I think we are not so sure.Mr. McTeer's excellent article opened my eyes to a key point that has, I believe, been overlooked in the current panic over the dollar's value, foreign investment, often via 'sovereign funds,' and US economic innovation.Even with a currently weaker-than-recently US dollar, our vital engines of economic growth and competitive advantage seem to be firmly in US hands, while lesser companies fall to investment by foreign interests.

Thursday, March 13, 2008

My last post on GE was just last week. The occasion was the release of CEO Jeff Immelt's 2007 compensation. For details, see my post. suffice to say, I found his latest year's compensation pretty much unrelated to GE's posting another year of total returns which under-performed the S&P500 Index.

This morning on CNBC, a network owned by GE, passages from Immelt's letter to shareholders were shown. Immelt is refusing to consider selling the entertainment sector of the conglomerate, while once again attempting to focus attention on his 'Ecoimagination' unit.

It was heartening to see one of the network's co-anchors clearly note that GE has under-performed the index during Immelt's entire reign, with a price chart to support the fact.

Immelt is to appear on CNBC tomorrow morning in an 'interview,' if you can call it that when the co-anchors interview the guy who can fire them.

But perhaps Immelt's most daring ploy this year is his announcement that he has bought $4MM of GE shares on the open market with his 'own' money, i.e., not via granted options.

Mike Holland, a guest host on CNBC's morning program today, noted the share purchase and touted the stock to viewers.

Here's my take on Immelt's GE share purchase move.

The first Yahoo-sourced chart nearby depicts the price of GE stock and the S&P500 for the past twelve-month period. It's clear that both have fallen sharply since the mid-2007 credit market problems. The index has fallen about 15% in that period, while GE has fallen in the vicinity of 22%.

Thus, per Mike Holland's comment this morning on CNBC, it's a buyer's market in the index and probably GE for investors with money and patience. Jeff Immelt has the first, thanks to GE shareholders, and probably the second, again, thanks to shovelsful of cash and options compensation over the past seven-plus years.

Since the S&P rises in roughly 70% of months, and it just fell nearly 15% in eight months, it's a safe bet that it will be rising by the end of this year.

If Immelt bought $4MM of S&P Index fund shares, it would be a signal to investors, especially in GE, that even Immelt thought the index would be, as usual, out-performing Immelt's company this year.

By purchasing $4MM of GE stock, Immelt will likely get a return similar to, but lower than that of the index over a like period. The nearby Yahoo-sourced 5-year price chart for GE and the S&P500 Index demonstrates how closely together the two tend to move.

Even if Immelt gives up some return on his $4MM by buying the lower expected return equity, he probably goes a long way toward saving his job, which is worth more like something north of $15MM/ year. If GE under-performed the index by 5 percentage points in the next twelve months, Immelt would only lose some $200K, but reap a public relations windfall that could easily stave off calls for his scalp.

I don't think Immelt is actually investing in GE as a vote of confidence in his management or the company's promising near-term opportunities and potential for a unique total return.

Rather, I think Immelt is simply making a very public bet on the direction of US equity markets for the remainder of this year, and probably next. After such a significant drop in price level of the S&P, there are several stocks with betas near 1 that would be relatively safe buys for a wealthy investor. GE's beta is .72, according to Yahoo.

I wrote in that linked post last week,

"As I have written in previous posts, when a CEO has been paid north of $10MM in cash, does anyone think he really cares what happens to the company's stock price anymore? Added to Immelt's prior $23MM of cash compensation, GE has now paid him over $30MM in just six years."

Immelt certainly has the money and, thus, the investing horizon to buy GE shares now and bet that, due to the broader market's recovery in the next twelve months, GE's share price will rise with the market, regardless of the company's actual operating performance.

I'd never say Immelt is not a smart man. In fact, he's extremely clever- for his own welfare. Too bad he hasn't been as smart or clever for his shareholders' benefit for the past six and a half years.

Wednesday, March 12, 2008

Yesterday's surprise move by the Fed to purchase up to $200B of troubled mortgage-backed securities from its primary dealers gave equity markets the sort of news that makes them look like a drug addict on their latest fix. The S&P500 Index rose 3.7% in response to the news of help in the credit markets.

This morning's Wall Street Journal front-page article states,

"The Fed said it would lend Wall Street as much as $200 billion from the central bank's own trove of sought-after Treasury bonds and bills for 28 days in exchange for a roughly equivalent amount of mortgage-backed securities, including some that can't ordinarily be used in transactions with the Fed. Uncertainties about the value of the underlying mortgages, plus forced selling by some investors to repay broker loans, have led many investors to spurn these securities, making them especially difficult to trade.

By taking some of these securities on its own books, the Fed is seeking to make its primary dealers -- the network of 20 Wall Street firms with which it typically does securities business -- more comfortable buying them from their own clients. It hopes this could lead to higher prices and thus lower yields on the mortgage-linked debt. A decline in those yields could help banks offer lower interest rates to prospective homebuyers.

Still, the Fed's efforts won't eliminate the root cause of the economy's problems: falling home prices and a mounting wave of mortgage defaults.

As collateral, the Fed will accept debt or mortgage-backed securities issued or guaranteed by Fannie and Freddie, also known as "agency" securities. It will also accept other residential-mortgage-backed securities, provided they are rated triple-A and not on watch for downgrade, though it didn't specify what type. Such "private label" securities have been especially difficult to trade, in part because the Fed doesn't accept them as collateral for ordinary money-market operations."

Of all the Fed actions of the past few months, and rate cuts extending back through last fall, I believe this one is very shrewd and probably will be productive.

As I wrote in this post yesterday, the current deleveraging-fire sale cycle of fixed income securities due to bank margin requirement increases has resulted in somewhat irrational temporary valuations on some fixed income instruments.

This move by the Fed is a very clever way of providing a floor under the prices of these assets in the marketplace. With participation by the primary dealers, whether directly or with paper purchased or taken as collateral from their customers, virtually any qualifying fixed income paper will immediately have a minimum price set in the market.

As such, this should stop much of the panic dumping of fixed income securities of still high quality which are not otherwise in a non-performing condition. In that regard, it's a good move for US financial markets and the economy in general.

What concerns me somewhat is the equity markets' reaction. I suppose I should remind myself that it is just a one-day move, not necessarily a trend. But I cannot help thinking that the index's and various individual equity's prices moved unsustainably higher based upon this surprise move by the Fed.

As the Journal article, and various pundits noted, it won't make US housing prices rise, or prevent mortgage defaults. But it will remove credit markets as another source of potential US economic weakness in the months to come.

Tuesday, March 11, 2008

My partner and I recently discussed this post, and the Wall Street Journal editorial by Holman Jenkins which motivated it.

After some initial back-and-forth comments during which it appeared that he and I disagreed, my partner's remarks focused on the duality of valuation in the recent case of various financial instruments whose values have plunged due to forced sales from margin calls.

How does one consider securities sold at incredibly low prices due to financing decisions? When the valuation is driven by temporary current market forces, not long term value, is 'mark to market' really valid? Specifically when the cause of the valuation change is a global deleveraging brought on by a change in bank collateral requirements of many institutional investors who have heretofore employed leverage in their strategies?

What is 'value' in such a case? As my partner noted, there is a duality, because perspective really determines it. The value is driven more by some bank's tougher margin requirements than the intrinsic value of the instrument, per se.

Is it reasonable for the balance sheet of a firm to reflect instantaneous market forces valuing its assets?

My partner initially decried anything but 'mark to market,' but then relented, somewhat, when I pointed out that all 'mark to market' really does is try to make an historically-based balance sheet become market-priced.

We have 'par' values on accounting books, and then each person's analysis to translate historically-costed assets into 'market values.'

At least one thing that is happening is that investors with cash are gorging themselves on improperly under-valued long term assets in a temporary meltdown.

For the purposes of accounting rules, we see real, tangible functioning financial service firms go out of business due to 'market valuation' rules simultaneous with bank lending contraction by way of margin rule changes.

As my partner, trained as an accountant, noted, using GAAP is simply following one set of rules, rather than another. But they are not etched in stone. I had a graduate accounting course professor who delighted in demonstrating that, by perfectly acceptable use of accounting assumptions and GAAP principles, he could not only vary earnings per share more than a marketing or production function could, but that he could accurately forecast that EPS for December 31 of the year on the day after New Year's of that same year.

Is the forcing a mostly historically-priced balance sheet to suddenly need to approximate real-time market values of use beyond the reasonable intent of financial accounting? Isn't it actually a sort of cash-like, dumbing down of GAAP principles, so that any idiot viewing the company's balance sheet and asset 'values' knows they are current?

But we have analysts and counterparties to also perform these tasks, with a more adversarial bent. Providing a 'market value' approximation for a firm is, as my partner and I agreed, a matter of perspective. Thus, a single, 'market value'-based of assets of a firm is probably an oversimplification anyway.

"Two years ago, General Motors Corp. Chairman and Chief Executive Rick Wagoner won a battle to keep his job, in large part by convincing his board he had the best plan for restructuring the auto giant.

Now, with GM still not making money, Mr. Wagoner has turned over responsibility for the company's sprawling day-to-day operations to Frederick "Fritz" Henderson. Speaking to reporters yesterday at the Geneva auto show, Mr. Wagoner outlined what his role will be in the auto maker's hierarchy, saying that he will focus on global growth, advanced technologies and environmental lobbying.

"At the top of the company, we've been somewhat stretched," Mr. Wagoner said. With "two people doing three or four jobs," he said, he "always felt like I was running from pillar to post." "

As CEO of GM, why didn't Wagoner do what was necessary years ago to be properly staffed and handle the company's problems? The Journal article continues by noting,

"But some investors are still unhappy with Mr. Wagoner's restructuring. GM is widely expected to lose money this year -- the fourth in a row -- even though it has cut $9 billion in fixed costs, shed a third of its hourly work force, and improved the quality of its cars and trucks."Where is the multipoint plan from Wagoner?" said SAM Asset Management President Bill Smith, whose firm owns about 30,000 shares. "When I got involved in GM shares two years ago, Rick was out there with a plan. He cut the dividend and so forth ... but where is the plan now?"

GM shares spiked last fall on enthusiasm about its new labor contract with the United Auto Workers, but since have lost almost half of their value. Yesterday, they closed at $23.07.

GM's market value of $13.06 billion is about a third of its value at the beginning of the decade when Mr. Wagoner became CEO."

Call me sceptical- hey, it's the name of the blog- but I don't see how the same guy who, as CEO, lost 1/3 of GM's value, is going to magically become an asset to the firm once he has a COO. If this were so important, why didn't he do it several years ago?

Perhaps GM shareholders, of which I am not one, have the pleasure of seeing Wagoner at last stop wrecking the company by his operational role as CEO. The piece concluded with Wagoner opining on performing less operational duties,

"Now, without having to manage daily operations, Mr. Wagoner plans to spend more time on so-called transformational issues such as environmental regulations and new technologies likely to reshape the auto industry down the road.

Mr. Wagoner said he also hopes to at least double his amount of annual visits to China, a fast-growing new market where GM has become well-established. Visiting roughly twice a year in the past "didn't feel right," he said. At the Geneva show, he unveiled a new type of hybrid power train that GM plans to offer in a range of vehicles in the U.S. by 2010."

Translation- keep Rick on the road making appearances and let someone more competent actually try to pull GM out of the ditch?

About Me

A well-educated veteran of US corporate strategy positions & hedge fund management, as well as research, product development and project work in consulting, strategy and equity management. Academic background in marketing, strategy, statistics and economics.
Currently own Performance Research Associates, LLC, through which I am involved in proprietary equity and equity options investment management.